MARCH 2015 – ISSUE 186
CONTENTS
COMPANIES
TAX ADMINISTRATION ACT
2392. Interest-free shareholder loans 2398. Mitigation of penalties and
2393. Asset for share transactions
interest
2394. Section 9D rules
DEDUCTIONS
TRANSFER PRICING
2395. Thin capitalisation and section 2399. Compliance conundrum
23M
2396.
2400. OECD’s BEPS action plan
Penalties and stolen money
INTERNATIONAL TAX
SARS NEWS
2397. Dividend payments to Holland
2401. Interpretation
notes,
media
releases and other documents
COMPANIES
2392. Interest-free shareholder loans
Loans between companies and their shareholders, or other group companies, are
a common method of providing finance in the South African corporate
environment. Loans of this nature may, however, give rise to tax implications in
the hands of the lender or the recipient, and careful consideration should therefore
be given to these transactions.
Dividends tax
1 Dividends declared by a company to its shareholders up until 31 March 2012
were subject to Secondary Tax on Companies (STC) at a rate of 10%. The Income
Tax Act, No. 58 of 1962 (the Act) also contains provisions designed to
circumvent tax avoidance transactions that enabled the shareholder of a company
to benefit in some way even though no cash dividend was actually declared.
Under these provisions, certain types of transactions gave rise to deemed
dividends with the result that STC became payable, subject to certain exemptions.
Dividends tax is levied at the rate of 15% on dividends paid on or after 1 April
2012, subject to certain exemptions, or the application of a lower rate of dividends
tax in certain circumstances. Low-interest loans may also fall within the
dividends tax ambit by virtue of these loans constituting a deemed dividend in
certain circumstances, giving rise to a liability for dividends tax.
Loans or advances from a company to a shareholder (or any person connected to
the shareholders) will automatically be deemed to be dividends in certain
circumstances.
The current deemed dividend provision applies where a debt arises “by virtue of
a share held in the company” and where the following conditions are present: the
debtor is a person other than a company; the debtor is a South African resident
and the debtor is either a connected person in relation to the company, or a
connected person in relation to that person. Broadly speaking, a “connected
person” in relation to a company means any company that forms part of the same
group of companies (where at least 70% of the equity shares in a controlled group
company are held by the controlling group company), or any person, other than a
company, who individually or jointly with any connected person holds, directly
or indirectly, at least 20% of the company’s equity shares or voting rights.
If all of these requirements are met, the company is deemed to have paid a
dividend in specie which is deemed to be an amount equal to the greater of the
“market related interest” in respect of the debt, less the amount of interest payable
2 to that company in respect of the relevant year of assessment. In other words, the
amount of the dividend is determined by applying an interest rate to the debit
balance on the loan during the year. For purposes of determining the deemed
dividend, the term “market related interest” is the difference between the “official
rate of interest” that applies for fringe benefits tax purposes, and as defined in
paragraph 1 of the Seventh Schedule (currently 6.75% per annum), and the actual
interest rate charged on the loan. Only the interest effectively forgone, and not
the capital amount of the loan, is deemed to be a dividend. If therefore, the loan
bears interest at an acceptable rate, there would be no deemed dividend. This can
be distinguished from the STC regime where the tax in respect of a deemed
dividend was calculated on the principal amount of the loan.
The dividend is deemed to be paid by the company on the last day of the year of
assessment, and the company is required to pay the resulting dividends tax by the
end of the month following its year-end. Since the dividend is deemed to be a
dividend in specie, the company (as opposed to the shareholder) is liable for the
tax.
In order for a shareholder loan to constitute a deemed dividend, the debt has to
arise “by virtue of” a share held in the company. The meaning of the phrase “by
virtue of” is not defined in the Act and guidance can be found in a number of
cases.
The phrase “by virtue of” was considered in the context of employment, in the
case of Stander v CIR [1997] 59 SATC 212, where the court considered the
meaning of the phrase “in respect of or by virtue of any employment or the
holding of any office”. The words “by virtue of” do not, in view of the court, bear
a meaning materially different from the words “in respect of” and referred to ST
v Commissioner of Taxes [1973] 35 SATC 99, at 100 where, in regard to the
phrase “by virtue of” Whitaker P stated at 100:
3 “ordinarily the phrase (and this was common cause between counsel) means
‘by force of’, ‘by authority of’, ‘by reason of’, ‘because of’, ‘through’ or ‘in
pursuance of’. (See Black’s Law Dictionary 4 ed 252). Each of these
definitions suggests there must be a direct link between the cause and result.”
The principles established in the Stander case were confirmed in the Supreme
Court of Appeal case of Stevens v CIR [2007] 69 SATC 1, where the court held
that there was no material difference between the expressions “in respect of” and
“by virtue of”. They connote a causal relationship between the amount received
and the taxpayer’s services or employment.
It is evident from the above that there has to be a direct causal relationship
between the holding of the relevant shares and the advance of the loan in question
in order for a deemed dividend to arise. The deeming rule will thus only be
triggered when a loan or advance has been made to a South African resident
person that is not a company (e.g. a trust or a natural person) who is a connected
person in relation to that company or a connected person in relation to the
aforementioned person (that is connected to the person who is connected to the
company).
To the extent that the amount owing to a company by a shareholder of that
company or other qualifying person, as set out above, was deemed to be a
dividend that was “subject to STC”, no deemed dividend implications will arise
in terms of the dividends tax regime. In other words, a debt that was deemed to
be a dividend that was subject to STC will not be deemed to be a dividend for
dividends tax purposes.
The term “subject to tax” is not defined in the Act, nor has it been the subject of
any South African court decisions. Guidance can, however, be found from United
Kingdom (UK) judgments in respect of the phrase. In the case of Paul Weiser v
HM Revenue and Customs [2012] UKFTT 501, the First Tier Tribunal considered
4 the interpretation of the double tax treaty between the UK and Israel and in
particular the meaning of the phrase "subject to tax". The case centred around the
meaning of the phrase "subject to tax" and the difference in international tax
treaties between this phrase and the phrase "liable to tax". In HM Revenue and
Custom's view, the distinction between the two phrases is that the expression
"liable to tax" requires only an abstract liability to tax (i.e. a person is within the
scope of tax generally irrespective of whether the country actually exercises the
right to tax) and therefore has a much broader meaning than the phrase "subject
to tax" which requires that tax is actually levied on the income. The First Tier
Tribunal decided the case in favour of HM Revenue and Customs such that relief
was not available under the UK-Israel tax treaty to exempt the pension from UK
tax because the pension in question was not subjected to tax in Israel.
Income would thus not be regarded as “subject to tax” if the income in question
is exempt from tax in terms of a statutory exemption from tax.
In the context of shareholder’s loans, unless STC was actually paid in respect of
the debt in question, such interest-free or low interest loan would be subject to
dividends tax. This effect appears to create unintended adverse consequences for
taxpayers in that, even though loans of this nature may not have constituted
deemed dividends under the STC regime as a result of the application of an
exemption, excess interest on the loan amount would be subject to dividends tax.
Employees’ tax
For employees’ tax purposes, the issue that requires consideration is whether a
“taxable benefit” as defined in paragraph 2(f) of the Seventh Schedule to the Act,
read with paragraph 11 thereof, arises in consequence of an interest-free or low
interest loan to a shareholder that is a connected person in relation to the lender.
In order to constitute a “taxable benefit”, the debt in question has to arise “in
respect of” the employee’s employment with the employer. As discussed above,
in terms of the applicable case law, there is no material difference between the
5 expressions “in respect of” and “by virtue of”. With regard to both, if there is an
“unbroken causal relationship between the employment on the one hand and the
receipt on the other”, the payment will be “in respect of services rendered”
(Stevens v CSARS supra). It is submitted that the same principle will apply for
purposes of paragraph 2 of the Seventh Schedule to the Act.
In order to determine whether an interest-free or low interest loan results in a
taxable benefit, one will have to determine the reason or cause for the granting of
the loan.
It is important to bear in mind that an interest-free or low interest loan to a
connected person in relation to the company (or a connected person in relation to
a connected person in relation to the company) will only be subject to either
dividends tax or employees’ tax, and not to both.
ENSafrica
ITA: Sections 64B, 64E and Seventh Schedule’s paragraphs 1, 2 and 11
2393. Asset for share transactions
(Editorial note: Published SARS rulings are necessarily redacted summaries of
the facts and circumstances. Consequently, they (and articles discussing them)
should be treated with care and not simply relied on as they appear.)
The South African Revenue Service (SARS) released Binding Private Ruling No
184 (BPR) on 11 November 2014, which deals with a proposed asset-for-share
transaction in terms of section 42 of the Income Tax Act No. 58 of 1962 (the Act).
6 The applicant was a resident family trust. The trust held all the issued shares in
Company A and Company B. It was proposed that the applicant dispose of its
shares in Company A to Company B so that Company A could become a whollyowned subsidiary of Company B. It was further proposed that, as consideration
for the transfer of the shares in Company A to Company B, Company B would
issue an additional equity share to the applicant.
The issue of the equity share to the trust would solely be to bring the proposed
transaction within the ambit of section 42 of the Act.
Despite the apparent artificiality of issuing an additional equity share to the
applicant, which already held all the issued shares in Company B, SARS ruled
that the proposed transaction would fall within section 42 of the Act.
Section 24BA of the Act is an anti-avoidance provision that potentially applies to
transactions where assets are acquired in exchange for the issue of shares as
consideration, including asset-for-share transactions in terms of section 42 of the
Act. Section 24BA will apply where the consideration is different from the
consideration that would have applied if the transaction were between
independent persons dealing at arm’s length. Where the consideration is not arm’s
length, the application of section 24BA will result in either a deemed capital gain
for the issuing company, or a deemed dividend in specie paid by the issuing
company.
SARS ruled that section 24BA would not apply to the proposed transaction on
the basis that it fell within the exclusion provided for in section 24BA(4)(a)(ii).
The said section provides that section 24BA does not apply where the transferor
of the asset will hold all the shares issued by the issuing company immediately
after the acquisition of the asset by that company.
7 SARS also ruled that the transfer of the shares in Company A (the assets) and the
issue of the equity share to the applicant, would neither constitute a donation for
purposes of section 54 of the Act, nor a deemed donation for purposes of section
58 of the Act (where there is inadequate consideration in respect of the disposal
of property), and that accordingly the proposed transaction would not have any
donations tax consequences.
Further, SARS ruled that Paragraph 38 of the Eighth Schedule to the Act would
not apply, implying that the proposed transaction would not be seen as a disposal
of an asset to a connected person for a consideration not reflecting an arm’s length
price.
This ruling is interesting in that, on the face of it, the issue of the additional equity
share to the applicant as consideration for the transfer of the shares in Company
A to Company B, does not appear to constitute:

an arm’s length consideration for purposes of section 24BA and Paragraph
38 of the Eighth Schedule to the Act; and

adequate consideration for purposes of section 58 of the Act.
SARS nevertheless ruled that these provisions would not apply.
Cliffe Dekker Hofmeyr
Binding Private Ruling No 184
ITA: Section 24BA, 42, 54, 58 and Paragraph 38 of the Eighth Schedule
2394. Section 9D rules
The Controlled Foreign Company (CFC) provisions seek to reduce the
opportunity for income to be diverted and taxed offshore in the hands of foreign
companies where:
8 
South African tax residents may exercise, directly or indirectly, a majority
of the voting rights in the foreign companies or

where South African tax residents may participate, directly or indirectly,
in the majority of the benefits attached to shares of the foreign companies.
In terms of Section 9D of the Income Tax Act, No. 58 of 1962 (the Act) a
hypothetical taxable income, “net income”, is calculated as if the CFC is a South
African tax resident. This net income may be included in the taxable income of
the South African tax resident shareholders.
Section 9D offers the following relief measures that avoid subjecting the CFC’s
net income to South African income tax:

the net income of the CFC is deemed nil where all foreign tax incurred by
the CFC is at least equal to 75% of the South African income tax computed
on that net income

amounts, other than tainted income, that are attributable to a “foreign
business establishment” (FBE) are excluded from net income.
Where a CFC conducts a genuine business established at premises outside of
South Africa, with sufficient on-site managerial and operational staff, it is usually
evident that the CFC conducts business through a FBE. In contrast, determining
whether foreign taxes incurred by the CFC will reach the 75% threshold can be a
time consuming and complicated computation, especially if the South African
taxpayer has numerous CFCs.
If a FBE exists and no tainted income is attributable to that FBE, no net income
will need to be included in the taxable income of the South African resident
shareholder. This result is regardless of whether foreign taxes incurred by the
CFC meet the 75% threshold.
9 However, as noted in the Explanatory Memorandum to the 2014 Taxation Laws
Amendment Act of 2014 (the TLAA), the current structure of section 9D still
requires the 75% threshold computation to be performed despite the fact that the
net income of the CFC is attributable to a FBE. This computation would also need
to be declared in an IT10B return that accompanies the annual tax return of the
South African shareholder.
In recognising this unnecessary burden, the TLAA proposes that a CFC’s net
income will also be deemed nil where:

all of the receipts and accruals of the CFC are attributable to a FBE and

none of those receipts or accruals relate to tainted income
This logical amendment removes the compliance burden where CFCs conduct
business through a FBE that does not derive tainted income.
A word of caution – the tainted income provisions of section 9D(9A) are
complicated and therefore should be considered carefully before relying on this
FBE relief. Tainted income includes the following passive and diversionary
income earned by CFCs from South African tax resident connected persons:

interest

royalties in respect of the use of intellectual property

rental of certain movable property

goods sold by the CFC

services performed by the CFC, other than certain services performed
outside of South Africa
In conclusion, now that the amendments in the 2014 TLAB have been enacted by
way of the Taxation Laws Amendment Act No.43 of 2014, the presence of an
FBE can reduce the compliance burdens associated with a CFC. However, careful
10 consideration must still be given to establish the existence and the impact of
tainted income.
Grant Thornton
ITA: Section 9D
Taxation Laws Amendment Act No. 43 of 2014
DEDUCTIONS
2395. Thin capitalisation and section 23M
In line with recent pronouncements by the OECD relating to the so-called Base
Erosion and Profit Shifting Project (BEPS), section 23M was introduced by the
Taxation Laws Amendment Act No.31 of 2013 (the TLAA). Section 23M of the
Income Tax Act No. 58 of 1962 (the Act) took effect on 1 January 2015 and has
a similar purpose to the thin capitalisation provisions of section 31 of the Act.
The Taxation Laws Amendment Bill No.13 Act of 2014 (TLAB), as tabled in
parliament contains a number of substantial amendments to the current provisions
of section 23M. The TLAB was subsequently enacted as the Taxation Laws
Amendment Act, No. 43 of 2014. A summary of the provisions of section 23M
following these amendments is set out below.
Section 23M sets an interest deduction limitation for a debtor and will apply if a
“controlling relationship” exists between the debtor and the creditor. A
controlling relationship will exist where a person directly or indirectly holds at
least 50 per cent of the equity shares or voting rights in a company. The interest
deduction limitation will also apply in respect of a debt owed to a creditor that is
not in a controlling relationship with the debtor where the creditor obtained the
funding for the debt advanced from a person that is in a controlling relationship
with the debtor. The interest deduction limitation will, however, only apply if the
11 amount of interest is not subject to tax in the hands of the recipient or not included
in the net income of a controlled foreign company and also not disallowed under
the provisions of section 23N dealing with the limitation of interest deductions in
respect of reorganisation and acquisition transactions.
The interest deduction limitation will be calculated on the aggregate of:
•
the amount of interest received by or accrued to the debtor; and
•
a percentage of the adjusted taxable income of the debtor to be determined
in accordance with a formula which links deductible interest to the average
repo rate for the year.
The formula will, therefore, be adjusted where there is a change to the average
repo rate together with a 400 basis point addition to the average repo rate. The
interest deduction limitation will have a ceiling of 60 per cent of the adjusted
taxable income of the debtor which will exclude the previous year’s assessed loss.
Any interest in excess of the limitation may be carried forward to the following
year. The interest deduction limitation will not apply to any interest incurred by
a debtor in relation to back-to-back loans where the creditor obtained those funds
from an unconnected lending institution in relation to the debtor and the interest
is determined with reference to a rate that does not exceed the official rate of
interest as defined in the Seventh Schedule plus 100 basis points.
National Treasury and SARS are of the opinion that section 23M has a broader
objective than the thin capitalisation provisions of section 31 and that section 31
will first apply to determine the correct pricing of the debt owed. Where the
amount of interest is taken into account in terms of a reorganisation and
acquisition transaction under section 23N, the provisions of section 23M must be
applied to any amount not already disallowed under section 23N.
ENSafrica
ITA: Sections 23M, 23N and 31
12 Taxation Laws Amendment Act No. 31 of 2013
The Taxation Laws Amendment Act No. 43 of 2014
2396. Penalties and stolen money
The South African Revenue Service (SARS) released Interpretation Note 80 on
5 November 2014 which deals with the income tax treatment of stolen money.
Apart from the fact that it is indicated in the Interpretation Note that stolen monies
must be included in gross income in the year of receipt, it is indicated further that
the stealing of money cannot be described as a trade and that the thief will thus
not qualify for a deduction to the extent that the monies must be repaid. It has
been indicated that, even though certain elements of a trade, for example the
intention to make a profit, repeated activities, planning and organisation, may be
present in the case of a thief, the thief’s activities lack the key commercial
character of a trade when it comes to sourcing the goods. Stolen monies and/or
other goods are not obtained through normal commercial means and are not
received as a reward for the provision of any goods or services.
On that basis the act of embezzlement, fraud or theft does not constitute a trade.
In a South African context a thief has another hurdle to cross, namely section
23(o) of the Income Tax Act No. 58 of 1962 (the Act), which provides that a
taxpayer is not entitled to deduct expenditure that constitutes a fine charged or
penalty imposed as a result of an unlawful activity carried out in South Africa or
in any other country if that activity would be unlawful had it been carried out in
South Africa.
The possibility of deducting penalties was recently considered by the Upper
Tribunal (Tax and Chancery Chamber) in the United Kingdom in the case of
McLaren Racing Ltd v Revenue and Customs Commissioners [2014] STC 2417.
13 The McLaren motor racing team participates in the Formula One grand prix
events that take place throughout the world. All teams participating in Formula
One have concluded an agreement between themselves and the International
Automobile Federation (the sport’s governing body) and the Formula One
Association (a company engaged in the promotion of the Formula One world
championship). This agreement is called the so-called Concorde Agreement.
McLaren was held to have breached the International Sporting Code as its chief
designer allegedly received confidential information pertaining to another
Formula One racing team. Pursuant to this allegation, the McLaren racing team
was ordered to pay a penalty of US$100 million in respect of a breach, less
income which was lost as a result of it losing points in the so-called Formula One
constructors’ championship. The ultimate penalty that was paid amounted to
approximately £32 million. The question arose whether this penalty was
deductible by the McLaren racing team on the basis of it constituting a
disbursement or expense wholly and exclusively laid out or expended for the
purposes of its trade or profession.
In holding that the penalty was not wholly and exclusively laid out or expended
for the purposes of McLaren’s trade, it was acknowledged that the penalty
constituted a disbursement or expense. However, it was indicated that a deliberate
activity which was not an unavoidable consequence of carrying on a trade did not
constitute an activity carried on in the course of that trade. It was said:
"In our view, a deliberate activity which is contrary to contractual obligations and
the rules and regulations governing the conduct of the trade, which is not an
unavoidable consequence of carrying on a trade and which could lead to the
destruction of the trade, is not an activity carried on in the course of that trade."
However, McLaren raised a different argument. It submitted that its trade
constituted the design, manufacture and racing of motor cars. As part of such
14 trade it employs designers and engineers. It was a so-called 'occupational hazard'
that employees might sometimes overstep the mark and act outside their scope of
employment. This argument was also dismissed. The court refused to accept that,
because an employer incurs a liability as a result of the acts of an employee, such
liability is incurred in the course of the employer’s trade. This was based on the
fact that the use of the confidential information did not constitute a normal or
ordinary activity of McLaren. It did not become such an activity simply because
it was carried out by an employee.
It was furthermore held that the reason the McLaren racing team paid the penalty
was not because it risked being excluded from the world championship (which
might have destroyed its business operations) but because the McLaren racing
team engaged in conduct that did not form part of its trade.
Accordingly, the deduction of the penalty was refused. It is probable that a South
African court might come to the same conclusion even though section 23(g) of
the Act, which previously required deductible expenditure to have been laid out
'wholly and exclusively' for purposes of trade, similar to the requirement in the
UK, has been amended. The section currently provides that expenses are
deductible to the extent incurred for purposes of trade. Given the facts of the
McLaren case, it would be unlikely that McLaren would be able to discharge the
burden of proof that at least some amount was incurred for purposes of its trade.
Since the penalty was intended to be a punishment, it still does not form part of
the expenditure laid out for the trade of the taxpayer.
Cliffe Dekker Hofmeyr
Interpretation Note No. 80
ITA: Sections 23(g) and 23(o)
15 INTERNATIONAL TAX
2397. Dividend payments to Holland
Dividends paid by a South African company to a resident of the Netherlands may
be subject to a dividend tax rate of 0% in South Africa. The premise of this
interpretation is based on Article 10(10) of the Protocol issued under the
Netherlands/South Africa double tax agreement (DTA), which provides as
follows:
“If under any convention for the avoidance of double taxation concluded after the
date of conclusion of this Convention between the Republic of South Africa and
a third country, South Africa limits its taxation on dividends as contemplated in
subparagraph a) of paragraph 2 of this Article to a rate lower, including exemption
from taxation or taxation on a reduced taxable base, than the rate provided for in
subparagraph a) of paragraph 2 of this Article, the same rate, the same exemption
or the same reduced taxable base as provided for in the convention with that third
State shall automatically apply in both Contracting States under this Convention
as from the date of the entry into force of the convention with that third State.”
What this section means is that where South Africa has concluded a DTA with
any other country after the date of conclusion of the Netherlands/South Africa
DTA, and such other DTA provides for, inter alia, the complete exemption of
dividends from dividends tax, the provisions of such DTA will automatically
apply to the Netherlands/South Africa DTA, with the result that the dividends
will similarly be exempt from dividend tax in SA.
There are currently only 3 DTAs to which SA is a party to and which provide for
the complete exemption of dividend tax, namely the DTAs with Cyprus, Kuwait
and Oman. The test, therefore, is to determine whether any of these DTAs were
concluded after the conclusion of the Netherlands/South Africa DTA.
16 The definition of the word “concluded” is absent from the DTAs, and the
Netherlands/South Africa DTA does not shed any light on when the document is
deemed to be “concluded”. According to the Netherlands/South Africa DTA, the
document was signed on 10 October 2005, and the date of entry into force is 28
December 2008, with the provisions of the Convention having effect for taxable
years and periods beginning on or after 1 January 2009. Having regard to the
SARS website, the publication date of the document is 23 January 2009.
The Kuwait/South Africa DTA, on which reliance is placed, was signed on 17
February 2004 and it was, according to the SARS website, published on 20 April
2007. In terms of Article 29 of the DTA itself, the date of entry into force is 25
April 2006.
As a result of this confusion between all these dates, a view has been expressed
that, because the actual convention between SA and Netherlands was concluded
in 2005, and because the DTA between SA and Kuwait came into force 25 April
2006, which is after this conclusion date, it may have the result that reliance can
be placed on the Kuwait/South Africa DTA to reduce the South
Africa/Netherlands dividends tax rate to 0%.
The writers have, in their previous article, issued a word of caution in that it is
likely that this position will not be attainable. After having had further discussions
with SARS, SARS’ view is that this is indeed the case.
As stated above, it is evident from Article 10(10) that reliance can only be placed
on the date of conclusion of a DTA. From a legal perspective, there are reported
judgments in SA that have held that word ‘concluded’, along with other common
usage variants, including the words “signed” and “reached”, all have to be
interpreted in the context of the notion of finality, i.e. when the agreement or
contract becomes ‘a binding act’ or a ‘final determination’. If this view is to be
accepted in the context of any DTA, the date of conclusion of any DTA would be
17 the date when such DTA reaches “finality”. Such date could either be the date
when the DTA was signed or the date of entry into force, depending on the facts
and interpretation of each DTA, which would certainly require further, detailed
analysis of each DTA.
SARS’ interpretation, however, seems to be that the date of ‘conclusion’ of both
the Kuwait/South Africa and South Africa/Netherlands DTAs are regarded as the
date when they were signed and, therefore, the 0% tax rate in the Kuwait/South
Africa DTA cannot apply to Article 10(10).
Interestingly, however, similar to Article 10(10) of the Netherlands/SA DTA,
Article 10(6) of the Sweden/South Africa DTA has a catch-all clause that “if any
agreement or convention between South Africa and a third state provides that
South Africa shall exempt from tax dividends (either generally or in respect of
specific categories of dividends) arising in South Africa, or limit the tax charged
in South Africa on such dividends (either generally or in respect of specific
categories of dividends) to a rate lower than that provided for …. such exemption
or lower rate shall automatically apply to dividends arising in South Africa and
beneficially owned by a resident of Sweden … under the same conditions as if
such exemption or lower rate had been specified…”
What is notable is that Article 10(6) in the Sweden/South Africa DTA does not
have any reference to the date of conclusion of the relevant DTA. This,
undoubtedly, will create arguments that a 0% dividends tax rate should apply to
dividends paid by a SA company to a Swedish resident shareholder which is the
beneficial owner of such dividend.
Of course articles of this nature are not intended to constitute advice, but rather
to air important tax issues in order to stimulate debate. Prior to entering into any
transactions it is, unquestionably, necessary to take detailed advice in relation
both to the law and also to the taxpayer’s particular factual circumstances. A
relevant issue in relation to the above legal analysis is that the public is not privy
18 to the bilateral negotiations involving DTAs, and therefore does not necessarily
have all the information pertaining to what was intended by these clauses.
It is also important to gauge the position of SARS in relation to such issues and
part of the debate which our articles are intended to stimulate involves gaining
insight into SARS’ position on these points. To this end our understanding of
SARS’ position is that, as set out above, the Kuwait/South Africa DTA was not
concluded after the South Africa/Netherlands DTA.
(Editorial Comment: This article highlights the need for DTAs to be examined
very carefully before application of their rules.)
ENSafrica
DTA : South Africa /Netherlands and South Africa / Kuwait
TAX ADMINISTRATION ACT
2398. Mitigation of penalties and interest
Judgment was handed down in the Tax Court on 18 November 2014 in the case
of Z v The Commissioner for the South African Revenue Service (case number
13472), as yet unreported.
The dispute concerned the calculation by the taxpayer of his capital gains tax
liability arising pursuant to the disposal of shares. In 2007 the taxpayer disposed
of his shares in a company for R841 million. In and around the time of the
disposal of the shares, a company (A) instituted a damages claim against the
taxpayer for an amount of R925 million which related to a transaction that took
19 place in 2003. Shortly after the damages action was instituted, the taxpayer agreed
to pay A an amount of almost R700 million in full and final settlement of its
claim.
In determining his capital gains tax liability for the 2008 year of assessment, the
taxpayer deducted a portion of the settlement amount paid to A from the purchase
price received for the disposal of his shares, which the taxpayer regarded as his
proceeds for purposes of paragraph 35 of the Eighth Schedule to the Income Tax
Act No. 58 of 1962 (the Act). The Commissioner for the South African Revenue
Service (Commissioner) disagreed with the taxpayer’s adjustment to the proceeds
from the disposal of the shares and increased the proceeds by the portion of the
settlement amount to arrive at the original proceeds of R841 million.
Various technical arguments were raised by the taxpayer as to why the proceeds
from the disposal of the shares should be reduced by a portion of the settlement
amount paid to A.
However, the Court agreed with the Commissioner’s findings that the inclusion
of the full amount received by the taxpayer for the sale of the shares for the 2008
year of assessment is unassailable and the appeal must be dismissed.
The purpose of this article is not to discuss the technical arguments surrounding
the application of paragraph 35 of the Eighth Schedule. The interesting aspect of
the case relates to the imposition of understatement penalties in terms of section
221 of the Tax Administration Act No. 28 of 2011 (the TAA) and interest in terms
of section 89quat of the Act (as it read at the time).
In the context of the understatement penalties imposed under the TAA, the
Commissioner had imposed a penalty of R47 million on the basis of “reasonable
care not taken” by the taxpayer or “no reasonable grounds existing for the tax
20 position taken”. The reasons cited by the Commissioner for reaching this decision
was that “the legislation and the facts are clear”.
The Court indicated that it was common cause that the TAA operates
retrospectively and its provisions, including section 270(6D), should apply. It
appears that the question of whether these provisions of the TAA and the decision
to impose such penalty may be unconstitutional and / or subject to an
administrative review application were not dealt with by the Court.
In any event, if these issues were to be raised it would most likely have to be
dealt with in a separate application to the High Court.
The Court concluded that the taxpayer's conduct constituted a “substantial
understatement” (as defined in the TAA) and the penalty falls to be reduced from
70% to 10%. In reaching this conclusion, we note that:

the Court held at paragraph 40 that it was of the view that “having received
advice, there were reasonable grounds for the appellant to take the tax
position which it did. Nor can it be said that he did not take reasonable
care – he did so by consulting the experts”;

the Court referred to the Tax Court, in the United States of America case
of Estate of Spruill v Commissioner [1987] 88 TC 1197, which had to
determine whether the fraud penalty was appropriately applied to an
understatement of estate tax resulting from a large under evaluation of
property. The valuation in turn was determined with the advice of an
attorney and an accountant and was based on an independent appraisal.
The court, in rejecting the penalty, had the following to say (88 TC 1197:
1245):
“When an accountant or attorney advises a taxpayer on a matter of tax
law, such as whether a liability exists, it is reasonable for the taxpayer to
rely on that advice. Most taxpayers are not competent to discern error in
the substantive advice of an accountant or attorney. To require a taxpayer
to challenge the attorney, to seek a “second opinion”, would nullify the
21 very purpose of seeking the advice of a presumed expert in the first place.
. . .’

the Court held that while section 270(6D) provides that in certain limited
circumstances, a senior South African Revenue Service official must, in
considering an objection against the imposition of an understatement
penalty, reduce the penalty in whole or in part if satisfied that there were
extenuating circumstances, there was no evidence that there were
extenuating circumstances which would warrant the reduction to below the
understatement penalty.
If one has regard to how Wepener J sought to apply the understatement penalty
provisions in sections 221 and 270(6D), it is noted that:

the Court firstly considered the taxpayer’s behaviour against the
understatement penalty percentage table in section 223. Having regard to
the penalty percentage table:
o
It was never contended that there was “gross negligence” or
“intentional tax evasion” by the taxpayer.
o
On the basis that the taxpayer obtained professional advice, it was
held that there were “reasonable grounds for the tax position taken”
and it cannot be said that “reasonable care was not taken in
completing the return”.
o
The tax return contained a “substantial understatement” as
defined and, as result of the other behaviours being excluded - the
penalty of 10% was imposed.

Only after the Court had tested the taxpayer’s behaviour against the
understatement penalty percentage table did it consider the application of
section 270(6D);

It may be debatable whether the correct approach is to consider section
270(6D) on its own (i.e. without first having regard to the penalty
percentage table).
22 However, the approach adopted by Wepener J appears to be the most practical
approach and avoids a judicial officer from having an unfettered discretion when
making a determination as to the extent of the reduction of the penalty in terms
of section 270(6D) (i.e. having regard to any extenuating circumstances).
In the context of the request for remission of interest in terms of section 89quat
of the Act (as it read at the time) it was also held that there is no reason not to
find that the taxpayer’s reliance on advice was reasonable and any interest must
be waived in full. It must be appreciated that the wording of section 89quat no
longer refers to “reasonable grounds” being contended by the taxpayer. Section
89quat interest may now only be remitted in “circumstances beyond the control
of the taxpayer”, which is far narrower than the previous wording of section
89quat.
These findings by Wepener J that having received professional advice it cannot
be said that there are “no reasonable grounds for the tax position tax” nor can it
be said that “reasonable care [was] not taken in completing [a] return” should
assist taxpayers when objecting to any understatement penalties imposed in terms
of the TAA.
Cliffe Dekker Hofmeyr
ITA: Section 89quat and Paragraph 35 of the Eighth Schedule
TAA: Sections 221, 223 and 270(6D)
TRANSFER PRICING
2399. Compliance conundrum
By now, most South African taxpayers should be aware that when they enter into
transactions with related parties who are not South African taxpayers, such
transactions should be concluded on terms and prices that are at arm’s length in
nature. The term “arm’s length” essentially indicates a position that two unrelated
23 parties would adopt in an open market transaction, as a willing buyer and willing
seller. Critical to managing tax risk for any taxpayer that has transactions of this
nature is being able to defend the transfer pricing (TP) position that they have
adopted and the only way to adequately do so is through the preparation of TP
policy documentation.
What is Transfer Pricing documentation?
As a starting point, it is important to highlight that, for now, it is not a statutory
requirement to prepare TP documentation in South Africa – but there is a sting in
the tail, and more on that later. Many years ago, SARS issued Practice Note 7 that
provided guidance on their approach to TP and what TP documentation should
cover.
This Practice Note was largely based on the Organisation for Economic
Cooperation and Development’s (OECD) guidelines. In this process, SARS also
pointed out that TP documentation should be relevant to each taxpayer’s
circumstances and that it was not expected that a taxpayer should spend a
disproportionate amount of money preparing TP documentation.
Unfortunately, many taxpayers have taken a very aggressive position and have
compiled a one or two page document that simply states what price they charge
their related parties – although this may deal with inter-group pricing, it is not
what the OECD and SARS would consider to be a TP document. TP
documentation should provide the user (in most cases, SARS or the South African
Reserve Bank) with insight into the following:
 the company and the group it forms part of, what products or services the
group sells and some financial and statistical information like revenue,
profit, number of employees, key locations etc.

the industry the company and group operate in, the regional and global
factors that affect that industry, the competitive landscape, etc.
24 
the functions that the company undertakes, the various risks it assumes and
the assets it uses to perform the said functions

the TP methodology that the taxpayer has elected to use in determining and
setting its prices and why it has not used any of the other recognised TP
methods

if appropriate (which in most cases it is), an economic analysis supported
by benchmarking studies and analysis, the outcome of which is a pricing
range commonly referred to as the inter-quartile arm’s length range.

In the context of what SARS expects to see when a taxpayer says that they
have prepared a TP document, when a taxpayer presents a one-page
document to SARS, they arguably compromise their position even further.
Critically, a taxpayer needs to discharge the onus of proof on why their
pricing is considered to be at arm’s length and merely stating that one
thinks that the price is fair does not do so. SARS, and any other revenue
authority, will want to see objective data or market information that
provides appropriate support. Coming back to the sting in the tail – when
submitting an ITR14 tax return, the taxpayer is required to do so on an
arm’s length basis. When answering questions relating to related party
transactions with non-residents, the taxpayer is asked to confirm whether
they have a TP policy document.
If the taxpayer answers “no”, there is an immediate red flag, as SARS will
question how the taxpayer knows that the tax return is submitted on an arm’s
length basis when he has not prepared TP documentation. By not having adequate
documentation or any documentation at all, the taxpayer is immediately on the
back foot – a precarious position from which to engage with SARS! The
alternative is to prepare appropriate TP documentation that could also serve to
reduce any potential penalties that SARS may wish to impose on the finalisation
of any TP audit by SARS.
25 Grant Thornton
ITA: Section 31
2400. OECD’s BEPS Action Plan
Transfer pricing and the concept of the Organisation for Economic Co-operation
and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Action
Plan have been receiving attention in the South African media and Parliament for
quite some time. Recently, on 19 November 2014, a session on transfer pricing
was held during a meeting of Parliament’s mineral resources and finance
committees. Presentations by the National Treasury and the South African
Revenue Service (SARS) during this session provide insight into possible future
transfer pricing legislation in South Africa. Most notably:

Over the last three years, the SARS Transfer Pricing unit has audited more
than 30 cases and made transfer pricing adjustments of over R20 billion
with an income tax impact of R5 billion.

A similar number of cases are currently in progress and others are in the
process of being risk assessed.

Legislative requirements for multinational enterprises (MNEs) to maintain
specific transfer pricing documentation is to be considered.

Legislative measures to address outcomes of the BEPS Action Plan (e.g.
country-by-country reporting) are to be considered.

Legislative framework for Advance Pricing Agreements (APAs) is to be
considered, as such advance agreements on transfer pricing between
taxpayers and SARS could alleviate the enforcement burden and encourage
compliance.

While tighter legislation may be needed, SARS recognizes the vital
importance of a balanced response within the confines of domestic and
international law, while not posing a deterrent to foreign direct investment.
26 Detailed discussion
Background
Over the past few months, transfer pricing and BEPS have been the subject of
discussions by Members of Parliament on various occasions. In September 2014,
one Member of Parliament called for a “comprehensive and clearly articulated
law which forbids transfer pricing” during a beneficiation colloquium of
Parliament’s portfolio committee on trade and industry.1 Earlier last year, transfer
pricing and the possible instances of BEPS in the mining sector were a topic of
discussion during a meeting of the Portfolio Committee on Mineral Resources.2
Against this background, the National Treasury and a research executive of SARS
presented on South Africa’s Tax Policy Structure and Transfer Pricing and BEPS
respectively during the meeting of Parliament’s mineral resources and finance
committees on 19 November 2014.
Corporate Income Tax, BEPS and Transfer Pricing
The presentation by National Treasury on South Africa’s tax policy structure
(with a focus on corporate income tax) and the presentation by the SARS research
executive provided a brief overview of the current corporate income tax base and
an explanation of what transfer pricing entails. While the presentations were part
of the meeting of the mineral resources and finance committees, it was noted that
the extractive industry, from a transfer pricing and BEPS perspective is
essentially no different than any other sector and is therefore not the sole cause
of concern.
Measures against BEPS
The issues of transfer pricing and BEPS were touched upon in the context of
South Africa’s need for foreign investment in light of the twin budget and current
account deficits. Most significant foreign investment comes from MNEs, which
are inherently engaged in cross-border transactions with related parties, e.g.
through the sale of goods, intangibles transactions, the provision of services and
the provision of funding. While such cross-border transactions are in principle
27 beneficial, they can result in abuse when used to shift profits in order to exploit
differences in tax rates between the countries involved. In other words, transfer
pricing itself is an essential feature of cross-border activities of MNEs and only
“transfer mispricing” is not acceptable.
The threat of BEPS for the corporate income tax base and the tax implications of
cross-border transactions and international taxation were addressed. It was noted
that South Africa plays a key role as a member of the BEPS Bureau Plus and that
a number of measures have already been implemented to address BEPS, some
even before the BEPS Action Plan was released by the OECD in July 2013.3 Such
measures include rules and regulations regarding transfer pricing, controlled
foreign companies, interest deduction limitations, hybrid instruments and entities,
the digital economy and exchange of tax information.
In addition, the Transfer Pricing unit established at the Large Business Centre of
SARS was mentioned as one of the responses to the threat of BEPS. In this regard,
it was noted that:

Audits require scarce skills, are resource intensive, requiring understanding
of company, industry, global value chain, strategic decision making,
business models, etc. and take at least 18 months.

As a result of limited resources there is a focus on strategic auditing – high
risk, high value transactions.

Over the last three years the Transfer Pricing unit has audited more than 30
cases and made transfer pricing adjustments of just over R20 billion (as a
conservative measure) with an income tax impact of R5 billion.

A similar number of cases are currently in progress and others are in the
process of being risk assessed.

The extractive industry is no different to any other sector and the industry
is not the sole cause of concern. However, due to the size and significance
of this sector in South Africa, it remains a key area of focus for SARS.
28 Implications
SARS indicated it takes the protection of the South African tax base seriously and
there will be an ongoing focus on strengthening SARS capacity and capability.
At the same time, there will be a continual review of audit and risk assessment
processes and an ongoing dialogue with MNEs on levels of tax compliance. On
an international level, SARS will continue its participation in and co-operation
with inter alia the OECD, the United Nations, the African Tax Administration
Forum (ATAF) and the World Bank. It will also continue its co-operation with
other tax administrations and review international approaches to the extractive
industry.
With respect to the future of transfer pricing and possible measures against BEPS,
it was specifically mentioned that:

Legislative requirements for MNEs to maintain specific transfer pricing
documentation is to be considered.

Legislative measures to address outcomes of the BEPS Action Plan (e.g.
country-by-country reporting) are to be considered.

Legislative framework for Advance Pricing Agreements (APAs) is to be
considered, as such advance agreements on transfer pricing between
taxpayers and SARS could alleviate the enforcement burden and encourage
compliance.
As a closing remark, SARS noted there is no easy solution and it has to work
within the confines of both domestic and international law. While tighter
legislation may be needed, SARS recognized it is vitally important to respond in
a manner that is balanced and does not pose a deterrent to foreign direct
investment. In this regard, it is worth noting that additional measures may come
from the Davis Tax Committee following its review of the corporate tax system
with special reference to tax avoidance (e.g., base erosion, income splitting and
profit shifting).4
29 Endnotes
1.
Clamour to end transfer pricing abuse, Linda Ensor, 4 September 2014.
See
http://www.bdlive.co.za/business/2014/09/04/clamour-to-end-
transfer-pricing-abuse.
2.
Portfolio Committee on Mineral Resources, National Assembly,
Wednesday 2 July 2014.
3.
See http://www.oecd.org/ctp/BEPSActionPlan.pdf for more information.
4.
On 17 July 2013, the South African Minister of Finance announced the
members of a tax review committee (the Davis Tax Committee) to inquire
into the role of the tax system in the promotion of inclusive economic
growth, employment creation, development and fiscal sustainability. See
http://www.taxcom.org.za/ for more information.
Ernst & Young Inc.
ITA: Section 31
SARS NEWS
2401. Interpretation notes, media releases and other documents
Readers are reminded that the latest developments at SARS can be accessed on
their website http://www.sars.gov.za.
Editor:
Mr P Nel
Editorial Panel:
Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof
KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC Foster
The Integritax Newsletter is published as a service to members and associates of
The South African Institute of Chartered Accountants (SAICA) and includes
30 items selected from the newsletters of firms in public practice and commerce and
industry, as well as other contributors. The information contained herein is for
general guidance only and should not be used as a basis for action without further
research or specialist advice. The views of the authors are not necessarily the
views of SAICA.
31